WASHINGTON The U.S. futures regulator has yielded on several contentious parts of a plan to crack down on commodity speculation, marking a modest victory for banks and traders who have lobbied to limit increased market oversight.
A draft of the final rule by the Commodity Futures Trading Commission, reviewed by Reuters late on Wednesday, maintains that the Dodd-Frank Wall Street overhaul law requires position limits -- caps on the number of contracts a single trader can hold -- to prevent excessive speculation in oil, grain, silver and other commodity markets.
But the CFTC modified areas of the plan that concerned big banks like Morgan Stanley and companies like Shell, including whether different arms of a single company must count separately managed positions as one, and whether swaps and futures positions can be offset.
While sticking to an unpopular plan to phase in limits over time as the agency gathers more data on the opaque $600 trillion over-the-counter derivatives market, the proposal shows regulators responding to concerns raised by the financial industry and Republicans.
U.S. regulators are also wrestling with how much leeway to give banks in hedging their own risk under the so-called Volcker rules, Reuters has reported.
"At least they're listening to the industry, because people were concerned that Chairman (Gary) Gensler wasn't," a derivatives lawyer told Reuters.
The final rule would still snag large passive index funds, which critics have blamed for causing a massive run-up in oil prices in 2008 by buying and holding futures contracts without regard to market fundamentals.
"They've completely shut the door on risk management exemptions" for dealers trading for large passive funds, said one lawyer briefed on the final draft.
It would also still have a major impact for the CME Group Inc and IntercontinentalExchange. The two largest futures exchanges in the United States have fretted that strict limits could drive trading overseas.
Surging food and oil prices this year renewed political pressure on the agency to crack down on speculators, blamed by some for high prices.
"The draft final rule on position limits, as currently written, is extremely weak," said Sen. Bernie Sanders, a staunch critic of the CFTC.
"At a time when the American people are experiencing extremely high oil and gas prices, this proposal will do little or nothing to lower prices and it will not eliminate, prevent or diminish excessive speculation as required by the Dodd-Frank Act," he said.
The 238-page draft, dated September 19, could still be subject to changes. The five-member commission and its staff have been divided on how to craft the rule. It is uncertain whether the CFTC will vote on the rule at its October 4 meeting as had been previously expected, according to one CFTC official.
"It remains a work in progress... and our commissioners haven't fully weighed in yet," said CFTC spokesman Steve Adamske, who declined to comment on the details late Wednesday night.
AGGREGATION POLICY CHANGES
One key change in the final draft relaxes some proposed requirements for some large commodities players that have ownership stakes in entities that hedge, deal and speculate.
The CFTC had initially wanted to add or aggregate positions for entities that share common ownership, regardless of whether they share trading strategies and control.
The agency now would allow some players to avoid aggregating all the different positions in various trading accounts, provided those accounts are independently controlled and the companies impose vigorous firewalls between their trading desks. The CFTC said it may enhance market liquidity for bona fide hedgers and promote efficient price discovery.
"It would be good news if they are going to relax that, it didn't seem to have a lot of justification," Julie Winkler, a managing director of the CME, told Reuters on the sidelines of a commodities seminar in London.
The CFTC said index funds would not be exempt. They would have to aggregate for positions in accounts or pools with identical trading strategies, including passively managed index funds.
The CFTC's rule maintains its proposal to apply position limits to the "spot month" immediately, but phase in limits for non-spot months after collecting 12 months of swap data.
Traders have argued there is no evidence speculators inflate prices, and say curbs could make prices more volatile by removing liquidity and sending business to overseas markets. CFTC's own economists have not found a causal link between speculation and price volatility.
"These changes still don't address the overall question - how will this rule impact liquidity and price discovery in these markets?" asked Frank Lucas, chairman of the Agriculture Committee, which oversees the CFTC. "The CFTC simply doesn't have the data to answer that question, and it shouldn't move forward until it does," he said.
CLASS LIMITS EASED
Another important change the industry has been seeking revolves around so-called "class limits".
Initially, the CFTC said it would apply the formula to exchange-traded futures, related over-the-counter swaps, and across both those classes combined -- meaning traders would not necessarily be able to offset a short position in the swaps market with a long position in futures, as many do.
Banks objected, saying that dealers hedge by relying on over-the-counter derivatives that mimic performance of exchange-traded futures. They had complained the CFTC plan would create a very distorted view.
The CFTC said it would relax the class limits so traders exceeding the futures limit can use opposing positions that fall underneath the swaps limit to reduce their overall net position. The CFTC added it will revisit the issue.
"While class limits can be an effective tool to address undue market power in a particular segment of the derivatives market, the commission has determined that such limits should not be imposed without additional data and analysis," the draft says.
The CFTC's plan applies to 28 commodities and for most markets would be based on a formula of 10 percent of the first 25,000 contracts of open interest, and 2.5 percent thereafter.
The CFTC is poised to expand the definition of who can claim exemptions from the limits as "bona fide hedgers" -- traders who use the market to protect themselves from price risk, as opposed to speculating on market moves.
The expanded definition responds to traders who said the original definition was so narrow that some genuine hedging activities would be interpreted as speculation.
The CFTC kept a provision requiring traders to comply with limits on a intraday basis despite concerns from firms such as Barclays over the difficulties of complying and sharing information on a real-time basis.
(Additional reporting by Eric Onstad in London; Editing by Jonathan Leff, Michael Urquhart, Bob Burgdorfer and David Gregorio)